Do Limits on Institutional Investment Increase Opportunities For Ratings Shopping at the Margin of Investment and Speculative Grade?

Rating agencies are expected to be concerned about their long-term reputation because if they lose the trust of investors their ratings would lose credibility and value. We expect that there is less effective monitoring and hence more opportunities for ratings shopping within speculative grades because pensions and other similar institutions known for effective monitoring are limited by regulatory and/or contractual constraints from purchasing those instruments. Utilizing annual data on US firms rated by Standard and Poor's, we find systematically better ratings outcomes in speculative than investment grades firms at the margin of investment and speculative grades, ceteris paribus, consistent with opportunistic behavior